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A Partnership for Good Governance:
A CEO's perspective on the relationship between management and the board

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Gordon Nixon
President & CEO
RBC Financial Group
Institute of Corporate Directors
2004 Fellowship Awards Dinner

Toronto, Ontario

Tuesday, May 18, 2004

Thank you and good evening. It's a privilege to be a part of the 7th Annual Fellowship Awards Dinner honouring corporate directors in Canada. I would like to begin by offering my own congratulations to our four honourees, about whom more will be said later. I also want to thank Bernie Wilson for chairing this event, as he has for the past six years.

I must say that when Bernie first asked me to deliver tonight's keynote address, I wasn't sure what I could usefully talk about. After all, finding something interesting to say about corporate governance to a group that includes governance experts and many directors would be a challenge at the best of times.

And when you consider that just about everything that could be said about this topic has been said (and often), it's downright intimidating. So I thought I would take a slightly different tack tonight and address governance from the perspective of management.

A recent poll showed corporate executives in the U.S. have fallen below politicians in terms of public trust and respect, so you may think management's opinion on governance is as useful as an arsonist's view on fire prevention. However, I believe management's view of how a board provides value and the relationship between management and its board are important to the oversight and strategic direction of a corporation.

A productive relationship between a board and management adds value above and beyond governance, while a non-productive relationship impairs value and increases cost.

As the CEO of a major Canadian corporation, I understand the importance of an active and demanding board in assisting management to perform to its full potential. Indeed, a board that is engaged, informed and independent will have a significant impact on a company's future growth and prosperity.

More and more these days, we are hearing the view that the governance pendulum has swung too far. Maybe yes, maybe no; but it is beyond dispute that in recent years there have been broad lapses in corporate governance in the private sector involving some of the world's largest banks and investment dealers, telecommunication and energy companies, mutual fund and money management firms, and the list goes on.

These have not been isolated cases and it is now apparent that many of the issues were widespread and systemic in nature, with personal compensation generally at the centre.

At the end of the day, I think we would have to agree that if the private sector is not prepared to reign in the excesses of the free market system, then we have to accept the consequences.

Reigning in excess, whether it is business activity, weakness in compliance, or executive compensation, is a joint responsibility between management and the board. If we fail to provide the necessary self-governance, then we will face excess regulation and inflexible rules which will be extremely punitive to public corporations.

For business, nothing can be valued more than the integrity of the enterprise. Without integrity, an enterprise cannot engender trust in its financial statements, in its business conduct, and in the way it deals with stakeholders. And without trust, it cannot succeed and grow over a sustained period of time. This is why an obsession with integrity must be embedded in corporate DNA starting right at the top.

Unfortunately, there are always a few rotten apples in the barrel. Large organizations are comprised of human beings with all their frailties, and some may find themselves faced with inappropriate activity by an individual or small group, despite having many safeguards in place.

The defining moment in these situations is the way in which a company identifies and deals with this behaviour. It is critical that a company takes decisive action, is open and transparent, and acts in the best interests of its stakeholders. Leadership at the board can significantly impact not only the way a company manages these types of issues, but also the process it employs in identifying and disclosing them.

As a consequence of recent corporate misbehavior, there has been much discussion about the need to completely overhaul corporate governance practices. This discussion has led to a thorough review of the duties and composition of boards, the relationship between the board and management, and corporate accountability to shareholders and other stakeholders.

Recent legislative and regulatory action may create the impression that governance challenges have been addressed. But I question how far we can go by relying on regulation alone in achieving the quality of corporate governance that is necessary for true business success.

Reliance on regulation has led some observers to view compliance procedures, forms, and structures to be as important as governance itself. In my view, this is a mistake. Good process does not automatically translate into good governance.

Don't get me wrong. The governance changes that have occurred as a result of regulation and shareholder pressure are, in totality, a good thing and were necessary to rebuild public trust. But they only go half way to ensuring good governance.

I believe effective governance should be an evolving process rather than a fixed set of rules. This more flexible approach depends on an active and informed board of directors that has the critical responsibility to act as a tough and demanding task master, pushing management to perform at its highest potential. An active board helps to ensure more effective and better management.

An indispensable element of good governance lies in the board's relationship with management. There are different views, not surprisingly, on how this relationship should function.

Some observers see directors as compliance officers, their role simply to ensure companies meet regulatory obligations in a timely and consistent way. Others believe boards should operate like constitutional monarchies, simply playing an advisory role.

I prefer a model in which the board is much more than a compliance officer and is much more actively engaged than simply being a source of advice. An effective board must be an active and strategic partner in overseeing risks and in guiding the current affairs and future direction of the company. PricewaterhouseCoopers summed it up nicely by saying that a board should not only look after today's business, but ensure there's a business to manage tomorrow.

So from my perspective, good governance requires a partnership in which directors are actively engaged with management, providing oversight, judgment and guidance. This requires a board consisting of informed, active, and independent directors, which benefits from a diversity of gender, thought and culture. And it requires the informed monitoring of how management is discharging its own responsibilities in matters ranging from performance, to risk taking, to compensation, to succession planning.

Today's regulatory and legal environment has placed enormous pressure on both management and boards. But in my view, we should be placing greater emphasis on culture and standards rather simply relying on compliance and oversight. Companies need process - they are required by law. But an organization that is focused solely on the compliance side of governance, cannot maximize performance.

If senior executives say that they are more afraid of losing their jobs from bad headlines than they are from bad results, what does it say about our future ability to take risk, to reward investors, and to succeed in the global economy. Frankly, directors must be prepared to stand up and support what is right, rather than what makes good public relations.

An effective board needs the ability to differentiate between governance and performance. A board must understand the balance between long-term value creation and quarterly results. It is too easy for management to fall into the quarterly earnings trap - after all, it is what analysts and media focus on.

But strategy, prudent risk-taking and long-term value creation are critical issues for any board, and they are issues where I think boards can and should be providing more leadership.

For example, boards should be engaged well in advance in shaping strategy around major or transformational transactions. They should have discussed and signed off on the general strategic direction their company might take, and therefore be prepared to discuss and challenge the merits of any proposal brought forward by management. In many cases, boards are surprised when major transactions are brought before them because there has been limited prior discussion about a specific transaction and the strategy behind it.

In most of these situations, the relationship between management and the board is lacking something. Boards are not there just to rubber stamp initiatives. Nor, frankly, do they have the ability to generally challenge management given the information and expert advice that management usually has when presenting a proposal. But if the relationship between the board and management is fluid and effective, then there should have been prior discussions around the strategic merits of a transaction well in advance of a specific discussion.

This interchange between a board and management will result in a broader consensus with all the facts and alternatives on the table and may impact the way management views an investment opportunity - which if you look at the track record, has often been through rose-coloured glasses.

I also believe that separating the role of Chairman and CEO makes a great deal of sense in terms of both board and management effectiveness, and this has been reinforced from my own experience. It has provided greater clarity around the separation of responsibility between management and our board. It also allowed our board to set its own agenda and facilitated greater engagement in the operation of our business.

Separating the two roles has also freed up a tremendous amount of time for me to focus on what I believe are the key responsibilities of a CEO, from strategy to performance management. It has given me more time to focus on clients, employees and other constituents. Managing a board takes a lot of time and is not something you want a CEO to focus on.

In addition, a separate chair is a good sounding board. I have clearly benefited from having someone of broad experience and with few biases to talk with about difficult and sensitive issues. In my view, there are few reasons, other than ego as to why a CEO would want to be chairman (although I hope this statement does not one day come back to haunt me).

A board of directors also has a special role in ensuring the integrity of the organization by demanding the highest levels of ethical behaviour and full transparency.

Transparency and the flow of information are key elements in the relationship between management and its board. If a board is well informed, it can do a better job in guiding management and confirming its overall direction. Transparency can also protect management from proceeding down a path that the board might later object to, and transparency enables management to discharge its fiduciary and regulatory responsibilities.

This audience knows more than most the importance of, and the need for, qualified, active and committed directors if a new governance model is to succeed. In fact, the Canadian Coalition for Good Governance has identified the quality of directors as the single most important requirement for good governance.

There are consistent qualities that can enhance the contribution of directors. From my perspective, the ideal directors are knowledgeable about our business, and bring the benefit of their broader experience and diversity. Ideal directors are helpful advisors who can be a sounding board for senior management.

It is important that directors bring experience to an enterprise. Most decisions are not black and white, but are made in the grey zone and many management teams have not managed through major change or crisis. Experienced directors can be extremely valuable for management to draw upon.

Strong directors are good communicators, capable of giving positive and negative feedback in a way that promotes improvement of decisions and the business in general. They take the time to meet independently with management and to represent the company in the community.

And finally, great directors must have the time to devote to their responsibilities, which is one of today's biggest challenges. I never thought I would say that being retired or semi-retired was a positive attribute for a director, but frankly, it is.

For a CEO and management team to be effective, they need to know that directors will challenge them and that they will be held accountable for their decisions. But as Guy Saint-Pierre has said, management also needs to know that the board of directors will support decisions, once they are made. So I want a board of directors that challenges management's views and insists on good decisions, but stands behind the decisions that are made.

This view is supported by Harvard Professors Colin Carter and Jay Lorsch, who recently surveyed 132 CEOs around the world. Their findings are clear. Eighty-two per cent of CEOs agree that non-executive directors must do more than ask questions - they must be sufficiently informed to contest management's view.

Challenging management intelligently is what directors are paid for. Media autopsies of Enron, Worldcom, Tyco and Adelphia - and we've had a few in Canada -- point to directors failing to act in the face of obvious red flags. If you believe that fire is first revealed by smoke, good directors must be diligent about watching out for smoldering issues before flames erupt. Directors should exercise controls over management, rather than management controlling directors.

I recognize, especially for large and diversified companies, that effective governance requires a great deal of preparation and a high level of director engagement. However, according to the same Harvard study, only 56 per cent of CEOs agreed that directors were well prepared for board meetings.

Even more revealing, only about 40 per cent of CEOs said their directors took time outside of regular board meetings to learn about their business. Frankly, this is unacceptable. CEOs need an active and engaged board to help ensure that the actions of management create value in a responsible and ethical manner.

The best directors, in my mind, are excellent coaches who are not interested in getting in the way of the players on the ice, but in pushing strategy in the right direction by challenging assumptions, pushing for focus, and demanding clarity in execution.

Much has changed since Irving Olds equated directors to parsley on fish -- decorative but useless. Unfortunately, this is what many in management used to want from their boards. But experience has taught us that management is much better off when they have a committed and able board. Indeed, various studies show there is a direct link between governance practices and bottom-line performance.

As a CEO, I can't stress enough that there is more to good governance that ticking off boxes in a ratings survey to meet the requirements of Sarbanes-Oxley, the OSC, the SEC and various stock exchanges. It's quite possible to have a board that is totally independent and unrelated and that meets all the requirements of the various regulatory agencies but, at the same time, have a board that is totally ineffective.

When you cut through it all, apart from regulatory requirements, good governance comes from having a strong-willed board that has done its homework and is prepared to speak up and constructively challenge management on its basic strategy and on vitally important and sensitive issues such as executive compensation.

Stated differently, good governance is more a matter of values than a process of law. When talking about good governance from a Board of Directors, we should always remember that it is easier to "believe in what you stand for" than to "stand up for what you believe in."

The record clearly shows that virtually all directors are prepared to "believe in what they stand for," but far too few are prepared to rock the boat and "stand up for what they believe in." It's just too easy to "go with the flow."

When considering all the corporate debacles over the past five years, it's troubling to note how few directors have resigned from boards on points of principle - almost none ……and when they do it is too late. Again, it's just too easy to rationalize any particular corporate decision and "go with the flow."

It's no secret that the role of a director has become much more difficult. As The Economist recently reported in an article entitled "Where's all the fun gone?" directors are now faced with longer preparation time, more information to digest, more time-consuming and detailed meetings, and more legal liability. But the role is an essential part of our capitalist system, and when it fails, so does the system.

In conclusion, I would hate to leave the impression that I would hold boards responsible for performance, or for anticipating or preventing all problems from occurring. The primary responsibility for performance lies with management; however, the directors play a critical role. Boards can constructively challenge management, influence performance, establish standards, provide strategic direction and influence culture, and we will be better off for it.

A strong board can be a great asset to management, and those that fail to realize this are not only missing an opportunity, they are failing in their responsibilities.

The Institute of Corporate Directors is playing an important role in helping to build better boards by educating directors and setting high performance standards. Perhaps part of that education should be a course on how management can effectively capitalize on its board of directors.

I would like to close by once again extending my thanks to the Institute for the great work they do, and my sincere congratulations to Larry Bell, Dick Currie, Guylaine Saucier and Harry Schaefer for their commitment, leadership and foresight in the area of corporate governance.

Thank you.


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